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Q)The shares of Borough plc have a current market price of 74 cents
each, ex-div. It is expected that the dividend in one year’s time will be 8
cents per share. The required rate of return from dividends on these
shares is 16% per annum.
If the expected growth in future dividends is a constant annual
percentage, what is the expected annual dividend growth?Sir the answer is 5.2% . they jumbled the market price formula of Po=Do(1+g)/re+g. But when I did the algebraic jumbling over the Re formula I got a different answer of 3.8%.If the growth is asked is it mandatory that we use the current market price formula only? Could you mention the logic behind why we get different answer when we use the other formula?
There is no other formula and there is no other way of doing it given the information in the question.
I guess that the reason you have got the wrong answer is because you have written the formula wrongly. The formula is Po = Do (1+g) / (re – g).
Also, Do in the formula is the current dividend. The numerator in the formula is (Do(1+g)) is the dividend in 1 years time, and this question gives the dividend in one years time (not the current dividend). So 0.74 = 0.08 / (0.16 – g)
0.74 (0.16 – g) = 0.08
0.1184 – 0.74g = 0.08
0.74g = 0.1184 – 0.08 = 0.0384
g = 0.0384/0.74 = 0.052 (or 5.2%)
I do explain this and the other complications that can arise in the exam in my free lectures. The lectures are a complete free course for Paper FM and cover everything needed to be able to pass the exam well.
You are the reason I passed PM first attempt so I always listen to the lectures first thing before I read the texts sir, the reason I got this doubt was I jumbled this formula re= Do(1+g)/Po +g instead of the Po one and I got a different answer. That’s why I get confused. I will do the Po formula from now on sir
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